Running out of cash is a common reason why many businesses decide to close up shop. So if having cash is so critical to the success of every company, why don’t more owners know how to predict what their cash flow will be next week or next month? It's because many businesses still don’t understand how cash flow is generated or used inside their own company.
To accurately understand your cash flow, look at the cash flow statement that is generated inside of the accounting application you use. Look specifically at the positives and negatives (inflow of cash received and outflow of cash in the form of paid expenses) that happened inside of your company that month to see what has changed. Another simpler way to do this is to look at your bank statement to see if you had more or cash at the end of the month or at the beginning.
Your Company's Inflow
These are the activities that increase cash flow inside your business, such as:
Net profit
Over the long term, a profitable business typically generates cash flow for the company. If sales exceed overall expenses, you will eventually have more cash to reinvest or pay out to the owner.
A decrease in accounts receivable
When less customers owe you money, this typically means that they have already paid for your product or service and that cash is available inside your company to use.
An increase in accounts payable
When you take additional time to pay your own bills to vendors, you keep the cash inside your company longer. This is similar to how you use a credit card: You get the product immediately but can pay for it with cash 30 days from now.
Look specifically at the positives and negatives (inflows and outflows) that happened inside of your company that month to see what has changed.
A decrease in inventory
All inventory that you buy needs cash to pay for it. The less inventory you have, the less cash it consumes. This of course needs to balanced with how much inventory your customer requires so you can deliver their order in the time period they expect.
A cash loan
Any loans that you get from outside financing sources adds to your cash, but remember: Loans need to be paid back eventually with future cash flow.
Your Company's Cash Outflow
Outflow refers to activities that decreases cash flow inside your business. These include:
Net losses
When expenses consistently exceed sales revenue, eventually you will run out of the cash that is needed to cover these losses.
An increase in accounts receivable
When this increases, it means more customers are paying you later and you don’t have the cash now. Typically, you must pay for the cost of these sales before the customer pays meaning cash is going out before coming back in to cover these expenses.
A decrease in accounts payable
This happens when you are paying bills more quickly or new vendors are giving shorter payment terms than existing suppliers.
An increase in inventory
This either means that you are stocking more inventory or customers are buying less or not what you thought they would. Either way, more cash is invested in your inventory.
Paying down financial loans
Any loan that needs to be paid back from borrowed capital reduces your cash to be reinvested or paid out to the owner.
Predicting Next Week's Cash Flow
Once you know what affects the inflow and outflow of cash in your company, you can start to predict how much cash you will need or have in the bank at certain planned time periods.
There are some automated tools that can help with this process. Applications like Cash Flow Tool, Float and Pulse can take the information directly from your accounting system and forecast your cash flow balance based on the history of your accounts payables and receivables. But this can also be done in a very simple and manual way if there is not an effective tool in your current accounting application.
- Open an Excel spreadsheet and list your current cash in the bank.
- Subtract from this cash balance any checks sent, but not yet cleared against this the bank account.
- Add any cash from accounts receivable and sales that you forecast you will collect next week.
- Review your accounts payable for any bills you need to pay next week and subtract this from the total.
- Then, subtract any cash that needs to be paid for inventory or other capital purchases that are not in accounts payable.
After these calculations are made, you will have an estimate of what your cash balance will be for the following week. For example:
Cash in the bank balance: $50,000
Minus checks not yet cleared: $6,000
Effective cash balance: $44,000
Plus accounts receivables and cash sales: $23,000
Minus accounts payable bills to be paid: $19,000
Minus other inventory/ purchases: $3000
Total estimated cash: $45,000
Every business needs to know if they will have enough cash to pay their monthly expenses and to make new investments. These simple calculations can help you track cash availability so you can stay ahead of the types of cash-flow issues that often lead to businesses shutting down.
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